United States: Partnership Tax Audit Reform And Private Funds

The new rules are generally effective for partnership tax years beginning after December 31, 2017, but partnerships may elect to be governed by the new audit rules for any tax year beginning on or after November 2, 2015, and before January 1, 2018

Key Changes Under the New Rules

  • The IRS is no longer required to look to partners of a partnership in order to collect tax deficiencies imposed as a result of a partnership audit. In the case of partnerships with many partners and complex holdings, the IRS previously had to determine the partnership level adjustment and then calculate the resulting tax liability of each partner for the particular audit year, making it difficult for the IRS to audit partnerships. The new rules permit the IRS to assess and collect, at the partnership level, any underpayment of U.S. federal income tax (including penalties and interest) that is owed by the partners as a result of a partnership audit.

  • Unless a partnership opts out of the new rules, any persons who are partners at the time an audit is completed will bear the cost of any underpayment imposed by the IRS on the partnership, instead of the partners who benefitted from the underpayment of tax in the earlier year being audited.

  • A partnership would be required to pay, in the year the IRS makes the adjustment, any "imputed underpayment" with respect to any assessment, determined by netting all adjustments to items of income, gain, loss, or deduction and multiplying that net amount by the highest tax rate applicable to an individual.

  • The imputed underpayment may be reduced based on partner-level characteristics (for example, if a partner is tax-exempt or otherwise subject to a lower tax rate), and it may also be reduced to the extent that one or more partners file amended returns to take into account all of the portion of the adjustment properly allocable to such partners, and pay any taxes due on such amended returns.

  • A partnership can opt out of the new rules only if it has 100 or fewer partners, and each of the partners is an individual, an estate, a C corporation, an S corporation, or a foreign entity that would be treated as a C corporation under U.S. law. A partnership with an S corporation as a partner has additional information obligations in connection with the opt-out election. The new rules do not permit a partnership to opt out if it has a partner that is itself a partnership and, therefore, the ability to opt out of the new rules may not be available for most private investment funds (e.g., the fund general partner itself is typically a tax partnership).

  • A partnership can make an election under new Section 6226 (Push Out Election), within 45 days after the audit is finalized, to shift a tax liability adjustment to the persons who were partners during the year(s) to which the adjustment relates. If the election is made, the individual partners affected would have to take the adjustment into account and pay additional tax for the current year based on the taxes that would have been due for prior years as a result of the adjustment, along with any penalties that may be due and interest at a rate that is two percentage points higher than the normal interest rate applicable to tax underpayments.

  • The Push Out Election applies only to partners whose tax liabilities increase as a result of a partnership audit — if a partner's tax liability decreases by reason of the adjustment, that decrease is treated as a reduction of partnership income for the year the audit is finalized instead of providing a potential refund to those who were partners during the taxable year under review. It is unclear how the Push Out Election would apply to upper-tier partnerships (or other pass-through entities) that are partners in the partnership under audit. If the Push-Out Election causes an upper-tier pass-through entity to bear the tax, a fund may prefer to make the election, even though it could benefit tax-exempt investors.

  • The concept of a "tax matters partner" has been replaced with a "partnership representative," who will have broad authority to act on behalf of the partnership in connection with audits or judicial proceedings, and who no longer has to be a partner of the partnership. With this change, funds are now allowed to designate a management company or investment advisor to serve as "partnership representative."

  • Partners no longer have the right to participate in, or receive notices relating to, any U.S. federal income tax audits of the partnership unless those rights are contractually negotiated with the fund (e.g., via a side letter).

Steps That Should Be Taken

In view of the new rules, both fund sponsors of, and investors in, private investment funds should consider amending (or causing the sponsor to amend) the audit provisions in existing fund agreements to address some or all of the following issues:

  • Allocating any taxes, penalties, and interest arising from an audit solely to those taxable investors of the fund who were partners in the year under audit

  • Requiring an opt-out election, if it is available

  • Requiring the fund to make the Push Out Election

  • Providing fund partners with information and notice rights relating to tax audits

  • Requiring investor consent to the selection or modification of the fund's partnership representative

  • Requiring investor consent before the fund's partnership representative can bind the partnership in an audit proceeding, litigation, or settlement relating to the partnership's federal income tax liability

  • Obligating the general partner to attempt to reduce the imputed underpayment by proving applicable modifications, such as lower applicable tax rates or the existence of tax-exempt or non-U.S. partners

  • Taking into account the partnership tax burden on the economics of the fund, including the tax distribution (and deemed distribution) provisions and general partner clawbacks

  • Detailing a mechanism for the fund to recover from the partnership's imputed underpayment from the partners, such as with offsets from payments that would otherwise be distributed to the partners

  • Providing for indemnification of continuing partners in the event of the fund's complete redemption of a partner's interest

  • Addressing the rights and protections of a selling partner in the event of a subsequent audit of partnership items relating to a period during which the seller was a partner

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.